Demystifying the paradoxical popularity of stock buybacks in a market environment characterised by high stock prices

Abstract

Since the inception of the Corporation Amendment Act in 2011 to improve Director and Executive remuneration accountability, Australian corporations have been conducting gigantesque stock buyback programs (SBPs) on an unprecedented scale. This paper aims to develop an optimisation model that rationalises the relationship between SBPs and equity incentive plans (EIPs) for a risk-averse employee before quantifying the net effect of SBPs on the EIPs. To incorporate their interdependencies, we model EIPs and SBPs as a system of simultaneous equations and estimate this system using two stage least squares. Consistent with the optimisation model’ predictions, obtained coefficients indicate that managers may be conducting on-market SBPs to increase the value of equity incentive payoffs. Additional path analysis reveals that managers of low-quality earnings firms are likely to conduct SBPs to increase per-share earnings and maximise their equity incentive payoffs, especially during the economic slowdown period where other firm shareholders may be facing a sizable decline in their wealth. These findings provide a deeper understanding of how SBPs may serve as an incentive to reduce agency problems or as a tool of wealth transferring among stakeholders.